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The Clearing in the Woods: Is Spain’s Good News Too Good to be True?


Spaniards finally received some two pieces of good news in May. The first item is that the Spanish current account balance was positive in May for the first time in modern history. The second is that the unadjusted employment numbers for both April and May came back with slight gains; slight, but gains nonetheless[1]. This has inevitably led the government to claim that the crisis is nearly over and, of course, to take all the credit for it. Spanish radio and print media have more or less echoed this line, with even critics of the government unusually florid in their praise.

Are the numbers all they are cracked up to be? Do they really denote a secular change in the trend of Spain’s economy or are they merely a wider variation of the pattern?

The balancing of Spain’s current account is important, of course, and the performance of Spanish exports is the one bright spot in the national accounts. Exports in March grew 2.7% over a year ago while imports plummeted by 15%, turning a February deficit of 2.7 billion euros into a surplus of 1 billion euros the following month (on total March exports of 20.2 billion euros)[2].


It is worth noting that the improvement in the current account has come from the collapse in imports rather than the increase in exports; imports in 2013 may be below the 2005 level. During the brief recovery of 2010-2011, imports and exports rose at almost the same rate. Spain’s exports are also exposed to exchange rate risk: as every major economy except Europe seeks to competitively devalue their currency, Spanish goods will remain relatively more expensive than those of non-Euro countries.


For the moment, exchange rate risk does not seem to be too much of a problem. Most of Spain’s major trading partners are in the Euro zone, with 70% of exports and 60% of imports from within the currency bloc, and thus present no currency risk. Spain runs a comfortable current account surplus with these markets, with the exception of Germany. Spain’s biggest deficits come from OPEC nations and China. While these deficits are not likely to disappear – Spain has almost no petroleum reserves – they are not likely to suffer from currency risk either. Both petroleum and the Chinese renminbi are pegged to the U.S. dollar, and the EUR:USD rate seems likely to remain stable as the Fed “tapers” any further quantitative easing.

It is worth noting that Spain is not unique in enjoying an improved current account balance: Italian and Portuguese current account balances are tracking very nearly those of Spain, though the latter country’s surplus is the largest in relation to its GDP.

Because all three Mediterranean countries share some key similarities in their international trade patterns: high dependency on intra-EU trade and high levels of imports from China and OPEC, it is reasonable to expect them to perform similarly. A scatterplot of current account balance versus the EURUSD exchange rate suggests that as strong Euro will negatively impact the current account balance (fewer exports and more imports of cheaper Chinese goods and petroleum products). A EURUSD rate of around 1.31 seems to be the equilibrium point for all three economies. The average exchange rate in March, April and May was 1.30, climbing to 1.32 in May.

currentaccounts scatterplots 

As important a development as it is, balancing the current account is not going to kick-start Spain’s economic engine by itself. Spain is not Germany, and Spain’s economy relies much more on domestic consumption than her northern neighbor’s does. That is why the unemployment number is such good news: anything that holds out the promise of reversing the horrific labor situation would be greeted with a red carpet. There is no hope of an improvement in domestic consumption so long as 27% of the active population is unemployed and while wages are falling to stimulate competitiveness.

The May jobless rate fell by 98,265 to 4.89 million, but this data is seasonally unadjusted. Taking into account the expected increase in hiring due to the onset of the tourism season, the improvement is only a few hundred; but that is still an improvement over the furious pace of job destruction of previous months. The trend is stronger than at any time since the 2010-2011 recovery; which coincidentally was the last time that the Spanish government began to make noises about “turn-around”, “inflection points” and – God forbid – even “green shoots”. This time we have been spared the “green shoots”; but it is also far from clear that the rest of the government’s claims are true. It is not evident that the government’s key labor reform is responsible for the increase in hiring, nor that the reasons for growth are internal. Even if the trend is sustained, Spain faces years of 20%+ unemployment, and the real possibility of a “triple dip” recession.

There are a number of reasons to believe that this may be so; but prudence would have counseled saving the rounds of self-congratulation at least until after the summer, always a time of traditionally high employment. Spain is expecting a very large increase in the number of international tourists this year, particularly from Russia and China, but also from traditional sources like Germany and the United Kingdom. With the exception of the latter nation, all are economies who have been spared the worst of the global recession. There is little reason to believe that domestic tourism will increase much: most Spaniards are staying at home or visiting their family’s pueblo[3]. International tourism is very welcome, but it will not last the year; and it abnormally large lay-offs in September and October may follow the abnormally large hiring in May and June.

For one thing, there is a possibility of a certain skewing of the data. Monthly unemployment data comes from the Public Employment Service (Servicio Público de Empleo Estatal or SEPE), which belongs to the Ministry of Employment and Social Security. A completely different set of employment data is published quarterly by the National Institute of Statistics (INE Encuesta de la Población Activa). It is important to note that there is a large discrepancy of over 1.3 million people between the two published figures due to differences in methodology[4]. The Public Employment Service fails to track the active population, which the EPA does do; thus long-term unemployed who have given up searching (at least through SEPE) are no longer counted.

So while the SEPE monthly data shows improvement, the fact that the INE survey shows slight decreases in the active population and large increases in the unemployed population should give us pause. Additionally, when we dig into the SEPE data, we find that the largest increases in employment came from: Agriculture and Fishing, Hotel and Restaurants, and in Construction – all very seasonal activities. In summary, it’s too early to tell if the employment situation has truly improved in Spain, even moderately. At most, one can conclude that the summer months look very promising, more so than they have in a number of years.


It might have been advisable to wait until July, when INE is scheduled to publish the next Population Survey; but it is understandable that the government should not wish to wait. It is under enormous pressure from Brussels, markets and its own citizens to show progress and results. Who cares if the good news is endogenous or exogenous so long as it is here to stay? There are important reasons to care, as a number of internal indicators point to continued weakness in Spain and the shallowness of the improvement.

The Bank of Spain’s data shows that Spanish businesses and households continue to be starved of credit. The total change in credit to non-financial institutions is stable near 1%; a sustainable recovery would require increases in credit facilities as businesses expand, generate inventories and lines of credit, invest in new plant and equipment; or as households begin to spend more on suppressed consumption of durables. In fact, we see none of that. Business and household credit has continued to fall and both are lower now than at any time in the crisis.  The reason total credit is stable is because the public sector has been borrowing more heavily.


Brussels already chastised Madrid for running the largest fiscal deficit in Europe last year: 10.6% of GDP. Even subtracting the 40 billion euros that were borrowed to recapitalize Spain’s banks, the adjusted deficit of 7.7% meant that the government still would have missed the “relaxed” target of 6.7%. Spain has significantly surpassed Moody’s Debt-to-GDP ratio estimate of 83% for 2013 and 89% for 2014; the government announced a figure of 88.2% at the end of the first quarter[5].

The government is borrowing more, but spending less. Spending has fallen to its lowest level since 2008, as part of the obligatory austerity measures. All types of private sector consumption, households and businesses also continue to fall and at faster rates than the year before. So long as unemployment remains high, wages remain stagnant and government deficit targets remain unmet, we can expect no recovery from domestic consumption – which means at least two more years with the extra wiggle room Brussels has given Madrid[6] to meet deficit targets, and probably more.


The Spanish government is betting the farm on an export-led recovery, but consumer and government spending combined equaled 80% of GDP in the first quarter of 2013[7]. Consumer and business confidence remain in the doldrums, with the construction sector showing no signs of recovery after five years of crisis, showing how late and half-hearted have been Spain’s measures in this area. Property developers and investors have been allowed to go bankrupt, but in an effort to protect lenders, both the government and the Bank of Spain have allowed some very shady valuations and accounting to keep book losses “reasonable.”


Yet the Spanish banking sector remains weak. Spanish banks remain dependent on ECB financing for liquidity[8]. Although the immediate threat of insolvency and bank runs has been calmed by the EU’s 100 billion euro line of credit, the Spanish government has only drawn approximately 40 billion euros from it. This is prudent: every euro drawn on the credit facility goes against Spain’s public debt, and the government doesn’t want to explode the debt-to-GDP indicator any more than necessary. On the other hand, it raises the question of whether Spain’s banks have really been made whole by the injections of capital and the transfer of non-performing loans (NPL´s) to the “bad bank” (SAREB). Fully utilizing the EU’s bailout fund would increase the debt-to-GDP ratio by approximately 4%; taking over SAREB would cost the government another 5% of GDP.


Neither scenario is imminent, but both are possible and would tip the debt-to-GDP ratio above 100%[9]. SAREB now administers approximately 51 billion euros in bad loans. Most are finished properties, but approximately 15% of the portfolio is in unfinished properties and undeveloped lots. Only 7% of the finished properties are currently – legally – occupied by renters; though Spanish banks have a very significant problem with “okupas” – squatters – who are very difficult to expel from unoccupied properties without a court order. The vast number of unoccupied properties (SAREB alone is administering 77,000 of them) makes it impossible for the banks to patrol all of these. Since investors might face years of legal battles over occupied properties, it is clear that this is a major problem. Given the astronomical unemployment rate and the growing number of citizens in desperate financial straits, the problem will only get worse. In fact, there is a website maintained by citizen activists which teaches you how to be a successful squatter (www. okupatutambien.net).


To make matters worse, the regional governments of Andalucía and Canary Islands announced that they planned to expropriate vacant, foreclosed properties for as long as three years in order to house destitute families[10]. This legally unprecedented action has met with severe criticism from Mr. Rajoy’s government, from the European Commission, from banks and from international investors. No one believes that, once in place, families can or will be forced to move out again after three years (if the crisis is even over by then); and everyone dreads the consequences of making Spanish investments any riskier than they already are. Nevertheless, Andalucía has already expropriated its first properties.

Banks were dealt a blow last week when Spain’s Supreme Court ruled that the interest rate floor clauses that were included in many mortgages were illegal, when these clauses were improperly or incompletely communicated. Although the ruling did not apply retroactively, and it does not outlaw the floor clauses themselves, it still potentially impacts about 1 in 3 outstanding mortgages. The resulting reduction in interest rates means banks could lose up to 1 billion euros per year in interest income, complicating their financial situation further[11].  

This is in addition to the EU Tribunal’s March sentence declaring Spain’s foreclosure law to be “abusive” and “illegal”[12] placing further pressure on Mr. Rajoy’s government to reform the foreclosure law; something the banks are resolutely against.

Surrounded by Trees? You’re Still in the Forest

There is a possibility that Mrs. Saenz de Santamaría is right when she declares that the economic recovery has now begun and that the worst of the crisis has past; even though we’ve never heard anything different from any government. On the other hand, a host of key macroeconomic indicators remain strongly negative: it is very hard to see Spain’s good news as being self-sustaining. Growth in some key markets is benefiting tourism; the exchange rate remains relatively favorable for exports outside the EU, while the recession has decimated imports; neither of these conditions is guaranteed to be permanent and both are out of the hands of the Spanish government.

The government is still benefiting from the backstop of the ECB’s Outright Monetary Transactions (OMT), and the Treasury has had no problem finding subscribers for short- and long-term bonds. Spain has already covered more than half of its financing needs[13] for the year at far lower rates than the punitive ones of 2012. Even so, both Spanish and Italian bonds are showing a disturbing tendency to creep upwards since May. While a return to the “bond cliff” of 7%, reached and briefly exceeded last summer, is not at all likely, there are still clearly doubts in the bond markets about Southern Mediterranean debt and the economies that guarantee it.


Last year’s labor reform was a positive step; and the pension reform now being studied by the government may be inevitable given Spain’s demographic challenge. But Mr. Rajoy has avoided the even more necessary and impactful reforms in the public administration that would liberate the economy from the burden of an oversized state, the duplication of public functions, the multiplication of public functionaries and their privileges. The savings generated there would undoubtedly pay for the necessary degree of austerity in the government accounts and even allow Spain to refund its now hollowed out education and R&D budgets. But in a country where regional party leaders are still called “barons” – and not in any figurative sense either – such a degree of political reform is unthinkable, even if Mr. Rajoy was interested in picking such a fight.

He is not willing to pick that fight; it is not his style at all. Mr. Rajoy is a patient man whose attitude is “wait by the river long enough and you’ll eventually see the bodies of your enemies will float by.” How else could a two time loser maintain his grip on the leadership of his party and eventually become President? It has served him in good stead. Now, Mr. Rajoy is waiting for the rising tide of global economies to lift all boats, and his as well. And it may work to the extent that Spain could begin to grow again very modestly. But slow growth will not employ the millions out of work, nor bring back the millions who have left Spain, nor make the social welfare system sustainable in time for the coming demographic crunch.

Time – hitherto a friend to Mr. Rajoy – may be turning against him. Mr. Rajoy faces elections in 2015; it is hard to see how he can win them if unemployment remains north of 20% and even harder to see it below that number. All the while, Spain is carrying a powder keg called Catalonia in its pocket: while Mr. Mas is most likely stoking the nationalist fires to gain leverage against Madrid – in other words, playing the old game – it is increasingly possible that both he and Mr. Rajoy misjudge the situation and unleash forces beyond their control. Catalan independence is not likely, but it becomes more so the longer the crisis lasts.

Spain is not out of the woods by a long shot.

Sources and Notes:

[1] Benoit, Angeline, “Spain May Registered Jobless Drops As Peak Tourism Season Starts,” Bloomberg, 4 June 2013
[2] Dowsett, Sonya, “Recession Helps Spain Book First Trade Surplus In History,” Reuters, 31 May 2013
[3] Large numbers of Spaniards in Madrid and Barcelona are economic immigrants and retain strong family and personal ties to the village or town of their birth. You will often hear them talking of “me voy al pueblo” – “I’m going to the village, as a frequent and low-cost vacation plan.
[4] The SEPE unemployment figure is a count of the actual number of qualified persons registered at the SEPE offices. The EPA is a survey of 60,000 households (approximately 180,000 persons) that uses a statistical model to estimate the total number of unemployed persons in the economy. There are four principal causes for the discrepancy in numbers of unemployed:

  1. SEPE counts only those qualified workers who are registered job seekers at their offices, whereas INE applies broader, internationally standard criteria for determining unemployed persons. To the extent that a worker is not registered at SEPE – for example, those who are no longer eligible to receive unemployment benefits – they are not counted;
  2. SEPE also excludes those persons who are either seeking a specific type of employment, and only that type, and those who are not immediately employable. INE includes anyone seeking any type of employment who is not currently employed and all those who would be ready to accept employment within 2 weeks of the survey;
  3. These is a discrepancy arising from a change in the definition of “unemployed person” in 2002 in the INE methodology, which was applied to attempt to improve the alignment between the SEPE and INE calculations;
  4. There is also a large category of persons who are receiving early retirement benefits from their former employer. These persons are indeed listed in the SEPE count, as they must be registered in order to receive their payment; but as they are not looking for work, they are not counted by INE.

The “official” unemployment figures are those of INE, for the purposes of Eurostat and other international agencies. Neither methodology adequately takes into account employment in the gray economy. From: “Por qué discrepan tanto  las cifras de la EPA de las del paro registrado,” El Periódico, 4 June 2013
[5] Table 11.8, Statistical Bulletin, Bank of Spain
[6] Benoit, Angeline, “Rajoy Sees Reprieve As Spanish Recession Evidence Mounts,” Bloomberg, 28 May 2013
[7] Contabilidad Nacional Trimestral de España, Instituto Nacional de Estadística. Last updated on 30 May 2013.
[8] As pointed out by Dr. Edward Hugh in a recent post. See the picture below:
[9] “Bankers Whisper: Spain’s Bailout Bill Could Rise,” CNBC, 6 May 2013
[10] Smyth, Sharon, “Spain Home Expropriation Plans Seen Violating EU Bailout,” Bloomberg, 13 May 2013
[11] “La banca perdería 1.000 millones en un año si eliminase las cláusulas suelo de sus hipotecas,” Idealista.com, 14 June 2013
[12] “La UE considera abusiva la ley española de desahucios,” BBC, 14 March 2013
[13] “El Tesoro coloca 3.511 millones, pero tiene que subir los intereses en el corto plazo,” Público, 21 May 2013

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